IRS Guidance on Income Tax Treatment of ERC Claims

The IRS updated its frequently asked questions (FAQ) to provide guidance for how to account for the ERC on income tax returns. Specifically, the FAQ addresses taxpayers that received an ERC but did not reduce their wage expense on their income tax return for the year in which they claimed the ERC and taxpayers that reduced their wage expense on their income tax return for the year in which the ERC was claimed but their ERC claim was later denied.

ERC claims and income tax returns

Eligible taxpayers could claim the ERC for most quarters in 2020 and 2021 by filing a Form 941, “Employer’s Quarterly Federal Tax Return,” or an amended Form 941. Taxpayers that claimed the ERC generally also were required to reduce the amount of their wage expense by the claimed ERC amount on their corresponding federal income tax return, often by filing an amended income tax return and paying additional tax, for the tax year or years for which the ERC was claimed. IRS delays in reviewing and processing ERC claims resulted in many taxpayers not receiving an ERC for extended periods of time, and many taxpayers still have not received their ERC. Some taxpayers did not amend their related income tax returns while they waited to receive their claimed ERC. Other taxpayers amended their income tax returns and paid additional tax but had their ERC claims subsequently denied by the IRS.

Crowe observation

Taxpayers were uncertain how to account for these circumstances, especially for 2020 quarters, where the period of limitations for amending income tax returns generally expired. The FAQ aims to provide guidance to these taxpayers.

FAQ on ERC and income tax

According to the FAQ, taxpayers that did not amend their corresponding income tax returns for the year in which the ERC was claimed and that received their ERC in a later year are not required to amend their income tax return (or file an administrative adjustment request [AAR]) for the year in which the ERC was claimed. Instead, the FAQ states that under the tax benefit rule these taxpayers should include the amount of their overstated wage expense as gross income on their tax return for the year in which they received the ERC. For example, taxpayers that claimed the ERC for the first quarter of 2021, received payment of the credit in 2024, and did not reduce their wage expense on their 2021 income tax return should include the amount of the ERC received as gross income on their 2024 federal income tax return.

Similarly, taxpayers that previously reduced their wage expense for the year in which the ERC was claimed but their ERC claim was later denied are not required to amend their prior year returns. Instead, based on a reasonable expectation of reimbursement of qualified wage expenses, the FAQ allows these taxpayers to increase their wage expense by the same amount as they previously decreased it on their income tax return for the year in which they received the denial of their ERC claim. The FAQ also provides that these taxpayers may, but are not required to, file an amended income tax return (or AAR) to reclaim their previously reduced wage expense. For example, taxpayers that claimed the ERC for the first quarter of 2021, reduced their wage expense on their 2021 income tax return, and their ERC claim was later denied can either increase their wage expense on their income tax return for the year in which the credit was denied or, if the statutory period to claim a refund is still open for 2021, file an amended income tax return (or AAR) to reduce their wage expense and claim a refund.

Looking ahead

The IRS still is reviewing and processing ERC claims. As a result, more taxpayers could receive their ERC or have their ERC claim denied long after the original claim was filed. Taxpayers should consult a reputable tax adviser to understand their options for handling ERC-related issues.